What is a unit trust and should I invest in one?

Whether you want to invest £100K or £1,000, you might like to pool your money with others rather than go it alone.

That’s what a unit trust offers. With this kind of investment, you put your money into a portfolio that’s already established and managed for you.

For the hands-off investor, unit trusts are a potentially simple way to invest in assets such as equities, bonds and property, if you are willing to take the associated risks.

Here you can find out more about how unit trusts work.

What are unit trusts?

Unit trusts are a form of collective investment set up under a trust deed.

Using pooled money, a fund manager will invest in a portfolio of assets on your behalf.

A form of unit trust is currently offered in the following countries:

• The UK, the Isle of Man, Ireland, Guernsey and Jersey
• Australia
• New Zealand
• Fiji
• Canada
• South Africa
• Namibia
• Kenya
• Singapore
• Malaysia

How do unit trusts work?

A unit trust is set up under trust law. A fund manager is assigned to invest the money in line with the fund’s objectives, and there’s a trustee in place to safeguard the assets and make sure the fund manager is acting in the best interests of the beneficiaries.

The fund is divided into units, and each investor buys one or more of these units to become a beneficiary.

Investors can sell their units if they decide to invest their money elsewhere, and they can usually name a beneficiary who will inherit their units if they die.

The price for each unit depends on the underlying value of the assets (Net Asset Value, or NAV), and this is usually calculated each day.

Unlike investment trusts, a unit trust is open-ended. That means the fund will grow and shrink as investors buy and sell units.

How do unit trusts make money?

The trust makes returns by investing in well-performing assets, usually company shares, bonds, property funds, and other assets.

The fund will pay out any quarterly or bi-annual returns as either income or growth, and you can usually decide how you want to receive the money.

Remember that returns are not guaranteed, and that you can also lose money.

Income – with this option, the fund will pay you a regular income in the form of dividends.

Growth – you can choose to have any returns reinvested to grow the size of your investment, which can act as a ‘compound accelerator’.

How much do unit trusts cost?

When you buy a unit, you’ll be offered a bid (buy) price and a sell price. The bid price is the amount you can buy shares for and the sell price is the amount you’ll be offered if you want to sell your shares back.

The sell price is usually lower than the bid price to help the fund manager make money, and the difference between the two is called the bid-offer spread.

Unit trusts also carry some typical fees. An initial charge is a percentage of the amount you’re investing, and it’s usually about 2%, but these fees are becoming less common.

Unit holders also need to pay for the professional work carried out by the fund manager in the form of an annual management charge (ACM).

It is a percentage calculated on the value of your units. For actively managed funds you can expect this fee to range from 1% to 2%, while passively managed funds usually charge management fees below 1%.

Some unit trusts will state an ongoing charge figure (OCF), which combines a number of fees, like the ACM, registration costs and custody fees.

What are the different types of unit trusts?

One of the main decisions you need to make when investing in a unit trust is whether you want it to be actively or passively managed.

Actively managed

A fund manager will aim to beat the market by buying and selling assets based on global trends, which means the fees are usually higher.

Passively managed

The underlying fund will grow and shrink according to an index (often called tracker or index funds), and the fees tend to be lower because it requires less hands-on management

There is no guarantee that an actively managed fund will outperform a passive one, and you will need to factor in the additional costs of management when making a decision.

A lot depends on the individual skill (or lack thereof!) of the fund manager.

A good active fund could be expected to outperform passive ones in the short term, while over the longer time, passive funds tend on to outperform active ones on average (because there is more variation between the best and worst active funds).

Another key choice is how and where the funds are invested.

You can choose unit trusts that invest in particular sectors, assets or regions, or those that take a more diversified approach.

Some invest in other collective investments, which are called multi-manager or fund of funds. There are also funds that make specific ethical investments.

Advantages of investing in unit trusts

• Invest small amounts – you can invest as little as £500, or even make regular investments of around £25 to £50.
• Managed for you – whether you choose an actively or passively managed fund, you don’t need to manage the assets, but you will need to choose when it is a good idea to buy or sell your units.
• Diversification – most funds invest in a variety of different assets, helping you diversify your portfolio to hedge against market volatility.
• Liquidity – you can usually sell your shares at any time, or at specific times in the year, making it relatively simple to access your money if you need it.
• Tax – although you will pay income tax on the dividends, this is charged at a lower rate than on other forms of income. You may also be able to hold the income tax-free if you open an ISA or pension fund, which might work well if you’re investing for or during retirement.
• Held in trust – because of the legal structure of a trust, the assets are held by a trustee or depositary and will be safe if the firm goes bust. You may also be entitled to compensation if the fund was mismanaged, and the FSCS could provide you with compensation up to £50,000 if the company doesn’t have the funds to do so itself.

What are the disadvantages of unit trusts?

• Less control – although you can select trusts that align with your investment goals and preferences, you won’t be able to choose the exact assets or ethical investments. There is the potential to lose out if markets perform badly, especially if you have chosen a high-risk fund. With an actively managed fund, the amount you make will also depend on the fund manager’s decisions, and it is crucial that you trust their expertise.
• Cost – you’ll still have to pay fees, even if the fund performs badly.
• Capital gains tax – you may also need to pay capital gains tax (CGT) when you sell your shares, depending on whether or not you’ve gone over the tax-free annual allowance.

Best performing unit trusts

The unit trust you choose will affect the income your investment generates.

It is worthwhile speaking to an independent financial adviser (IFA) to decide which type of unit trust suits your goals, risk tolerance and circumstances.

An IFA will also have insights on the best performing unit trusts and can help you select the one that’s right for your investment strategy.

Here are five funds that have come out on top recently:

How can I buy unit trusts?

Once you’ve done your research and you’re fully equipped with the knowledge you need to get started with your investment, you can buy units in a number of ways.

You could go through an agent, broker, or IFA, or buy them yourself either directly with the fund management company or through an online fund platform or stockbroker service.